The Closing Bell
4/8/17
Statistical
Summary
Current Economic Forecast
2016 estimates
Real
Growth in Gross Domestic Product -1.25-+0.5%
Inflation
(revised) 0.5-1.5%
Corporate
Profits (revised) -15-0%
2017 estimates
Real
Growth in Gross Domestic Product +1.0-2.5%
Inflation +1.0-2.0%
Corporate
Profits +5-10%
Current Market Forecast
Dow
Jones Industrial Average
Current Trend (revised):
Short
Term Uptrend 19268-21635
Intermediate Term Uptrend 11891-24743
Long Term Uptrend 5751-23298
2016 Year End Fair Value
12600-12800
2017 Year End Fair Value
13100-13300
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2254-2587
Intermediate
Term Uptrend 2084-2688
Long Term Uptrend 905-2591
2016 Year End Fair Value
1560-1580
2017
Year End Fair Value 1620-1640
Percentage
Cash in Our Portfolios
Dividend Growth
Portfolio 57%
High
Yield Portfolio 54%
Aggressive
Growth Portfolio 55%
Economics/Politics
The Trump
economy is providing an upward bias to equity valuations. This
week’s data turned negative: above
estimates: weekly purchase applications, month to date retail chain store
sales, weekly jobless claims, the March ADP private payroll report, the March
ISM manufacturing index and the February trade deficit; below estimates: weekly
mortgage applications, March nonfarm payrolls, March retail chain store sales, March
light vehicle sales, February construction spending, the March manufacturing
and services PMI’s, the March ISM nonmanufacturing index; in line with
estimates: February factory orders and February wholesale inventories.
The primary indicators were also negative: February
factory orders (0), February construction spending (-) and March nonfarm
payrolls (-). Other factors to consider are the anecdotal
evidence we keep getting on the weakening used car and student loan markets as
well as the falling estimates of first quarter economic growth. I score this week a negative: in the last 79
weeks, twenty-five were positive, forty-four negative and ten neutral.
Atlanta Fed
slashes first quarter GDP growth estimate to 0.6%.
Net, net, this
week’s stats break the recent trend toward being mildly upbeat. But keep in mind
that it is just one week; so it doesn’t mean that there will be no more
positive numbers. That said, as you
know, I have been much less impressed with the supposed strength in the economy
than many others. However, I did accept
the notion that the post-election Trump euphoria had some impact on economic
activity, which would account for the recent less negative tilt in the
data. The issue may be, will that
improvement in attitude/activity be short lived based on the disappointments
experienced in the advancement of the Trump/GOP fiscal agenda? The stats will tell us soon enough.
Update on big
four economic indicators (medium):
On the political
side, it was all about trying to make a comeback from the recent failure of the
healthcare bill---which didn’t happen. Despite several efforts on both sides,
the GOP simply couldn’t get close to compromise. That didn’t keep the leadership from floating
a hope balloon just before leaving on Easter break. Whether that has any substance or is just a
political ploy, we will know soon enough.
In addition, it
appears that the house, senate and president have different plans for tax cuts;
so legislation will not likely be forthcoming anytime soon. That clearly damages the economic optimists’
case that the Trump fiscal plan will provide an immediate boost to growth in
two ways: (1) it dampens the degree of improved post-election sentiment that
might encourage spending and investing and (2) it delays any material benefit
from actual tax cuts. That said, I have
been and remain a skeptic that tax reform means major tax cuts simply because
the math doesn’t work. Nonetheless, if a
simpler, fairer tax code could be produced, it would be a long term economic
plus; it just wouldn’t create the fuel for accelerated growth that the
dreamweavers have been hoping for.
Still all is not
bad. As you know, I believe that Trump’s
effort at downsizing and rationalizing the bureaucracy will likely have a bigger
impact on the economy than I originally forecast. As a result, I have added 25 to 50 basis
points to our long term economic secular growth rate assumption. ‘That,
of course, sounds a good deal more precise than I want to be; but you have to
start somewhere. So just be aware that
this number could easily go higher or lower.’
In addition, the
new Trump proposals on amending NAFTA and other trade relations are a good deal
more favorable to free trade than has been apparent in his rhetoric. While we don’t know the details of this
week’s China negotiations, I am hopeful that I can stop worrying about a
disruption in global trade contributing to economic weakness.
Finally, I am
not sure how to judge, the US action against Syria. I opined in Friday’s Morning Call, that this
action could have been more about Trump proving to the Russians and Iranians
(and perhaps the Chinese) that he could be a hard ass than any kind of moral
outrage over civilian deaths. The key
here is the response from Russia and Iran.
Overseas, the
data this week was mixed with the eurozone continuing to show improvement---the
Greek bailout and worsening liquidity in Italian banking system
notwithstanding. On the other hand, the
numbers out of Japan and China were nothing to get excited about. That leaves our ‘muddle through’ scenario in
place.
Bottom line: this
week’s US economic stats turned negative.
Whether that proves to be just a one off occurrence or marks the end of
a modest pickup in economic activity stemming from the post-election elation,
we will just have to await further evidence.
If it is the latter, then short term, that could mean that I have to
reverse the recent slight increase in our forecast. As I noted above, more is needed to make that
call. On the other hand, based on
Trump’s deregulation efforts, I remain confident in my recent upgrading our
long term secular growth rate by 25 to 50 basis points.
Our (new and
improved) forecast:
‘a possible pick up in the long term secular
economic growth rate based on lower taxes, less government regulation and an
increase in capital investment resulting from a more confident business
community. However, there are still a
number of potential negative unknowns including a more restrictive trade policy
(now perhaps fading as a concern), a
possible dramatic increase in the federal budget deficit, a Fed with a proven
record of failure and even whether or not the aforementioned tax and spending
reforms can be enacted.
It is important to note that this change in
our forecast is all ‘on the come’ and hence made with a good deal less
confidence than normal. Nonetheless, I
have made an initial attempt to quantify this amended outlook with the caveat
that it will almost surely be revised.’
The
negatives:
(1)
a vulnerable global banking system. This week, I linked to an analysis of the
Italian banking problem---which is not minor and is not going away. How much spillover effect it could have on
the international banking system is an unknown because we don’t know the extent
of the counterparty risk on the Italian banks’ balance sheets. So it is a risk of indeterminate size.
On the other
hand, it appears that Greece and the EU are near an agreement for the next
round of bail out funds---once again postponing the inevitable.
In the US, the
head of the National Economic Council came out in support of bringing back
Glass Steagal. This would be another big
step in reducing the balance sheet risk in our banking system (medium):
(2)
fiscal/regulatory policy. I continue to hope that the Donald’s new
policies will prove beneficial to the economy and I can eliminate this factor
as a negative. Certainly, the regulatory
element is unfolding as well if not better than anyone could have
imagined.
On the
other hand, Trump/GOP’s fiscal program is a mess. First of all, one would have
thought that with seven years to analyze and develop a bill to repeal and
replace Obamacare that was acceptable to all parties, the republican
congressional leadership would have been ready on day one to present
legislation that would pass---‘one would have thought’ being the operative
phrase. Having failed, the leadership’s
strategy is ostensively working to achieve a compromise that can keep the
forward momentum. They tried it once and
got shot down. Then on Thursday, they
tried again. I have no idea if they are
telling the truth or just trying to cover their ass with the appearance of
effort as a defense against the ranker of the unwashed masses when they go home
on Easter empty handed.
Of
course, there is the second major pillar of the GOP program---tax reform, which
if passed would take some of the sting out of the republicans’ pitiful efforts
at healthcare reform. Think again,
fellow fun lovers. According to Ryan,
the house, senate and white house all have disparate plans which until recently
no one seems to have understood or attempted to do anything about. So once again, it seems the optimists may
have to move their forecasts for an invigorating tax cut out on the
calendar---if indeed a true cut ever occurs.
Not to beat a dead horse, but you know that I highly doubt congress can
produce anything beyond revenue neutral tax reform.
To end
on a more upbeat note, I believe that Trump and the GOP congress will
ultimately deliver healthcare reform, tax reform and some infrastructure
spending legislation and that it will be a net positive for the long term
secular growth rate of the economy. But
it is not apt to have nearly as big an impact as many of the dreamweavers would
hope.
The
bottom line here is that (1) deregulation is lifting our economy’s long term
growth prospects, (2) the Trump/GOP election victory was not the magic elixir
that many seemed to believe, (3) however, I believe that they will still
achieve some form of tax reform and infrastructure spending legislation which
will also prove beneficial to the economy’s long term growth but (4) the
restraint on accomplishing aggressive tax and spending programs is not GOP
harmony but math. In my opinion, they
simply won’t get done and if they do, it will be more harmful than beneficial.
(3) the
potential negative impact of central bank money printing: The key
point here is that [a] the Fed has inflated bank reserves far beyond any
comparable level in history and [b] while this hasn’t been an economic problem
to date, {i} it still has to withdraw all those reserves from the system
without creating any disruptions---a task that I regularly point out it has
proven inept at in the past and {ii} it has created or is creating asset
bubbles in the stock market as well as in the auto, student and mortgage loan
markets.
The big news
this week came from the minutes of the last FOMC meeting in which the narrative was considerably more
hawkish than had been conveyed in the statement following the meeting or the
recent numerous comments of Fed officials.
The surprises were [a] beginning to shrink the Fed balance sheet was
given serious consideration and [b] concerns were expressed about the level of
equity valuations.
What does that
mean? With this group, there is no
telling. It could have been nothing more
than the mental masturbation of a bunch egg head bureaucrats that are clueless
about the potential disaster they have wrought.
Or it could once again demonstrate that the Fed has been, is and forever
will be a day late and dollar short in its policy moves.
We already know
that the Fed has missed the timing for a move to unwind QE. The question now is, will it start the
process at the very moment the economy is starting to weaken? As you know, I am not that concerned about
the economy because QE did little to help, so I don’t imagine that its reversal
will be that disruptive. On the other
hand, if investors realize that the Fed has f**ked the pooch once again, mean
reversion could be the result. And
indeed that has been my number one risk all along.
Mudding the
waters somewhat, Draghi stated this week that there was insufficient reason to
begin to unwind the ECB’s version of QE---which was amazing in that the EU’s
numbers of late have been better than our own.
Of course, he was immediately contradicted by a Bundesbank official,
demonstrating that central bank double talk is a global disease. However, if Mr. Draghi is serious, then an
easy ECB and a tightening Fed could set up a currency problem that would have
implications for trade---something I would just as soon avoid, given the
Donald’s comments on ‘currency manipulators’.
My bottom line
remains that when the unwinding of the global QE/ZIRP/NIRP begins in earnest, I
believe that it will have only a modest effect on the economy but a noticeable
one on the Markets.
(4) geopolitical
risks: conditions are heating up in Syria.
I am less concerned about the Syrians than I am about a potential
faceoff with Russia who, as you know, is a major supporter of Assad. I am stunned that suddenly Trump is getting
his panties in a knot after condemning both Bush and Obama for foolhardy
involvement in the Middle East. That
said, the cruise missile strikes may have been another Trump negotiating ploy
to let the Russians, Iranians, Chinese and North Koreans that there is a new
sheriff in town---only carrying a good deal more risk than his other
negotiating ploys. Whatever his
motivation, I hope that he is not contemplating wasting more American treasure
and lives over a bunch of f**king arabs who will go on killing each other
irrespective of what we or the Russians do. Right now the important thing is
the response.
(5)
economic difficulties in Europe and around the globe. This week, the EU data flow continues to
improve while the Chinese aren’t doing so well:
[a] the March
EU countries manufacturing PMI’s were above expectations; March EU retail sales
were slightly better than anticipated; the March UK services PMI was better
than projected.
[b] the March
Japanese and Chinese manufacturing PMI’s were up but below estimates; the March Chinese services and
composite PMI’s hit a six month low.
Other
relevant international developments includes the promising resolution of the
Greek bail out issue, the deterioration in the Italian banking crisis and the
apparent lack of cooperation within OPEC as well as the ramp up of shale production
in the US.
OPEC’s number 2 plans major increase in production (medium):
In sum, the
eurozone economy continues to improve though the stats out of Asia are a bit
less promising. That provides little
reason to alter our ‘muddle through’ forecast.
Bottom
line: the trend toward economic stability
hit a bump in the road this week. I have
no idea if this was just a one off performance or it marks the end of the
economic effects of the post-election boost in sentiment. Time will tell us.
More importantly
for the long term, the Donald’s drive for deregulation and improved
bureaucratic efficiency is a decided plus; and as a result, I inched up my
estimate of the long term secular growth rate of the economy. In addition, a more reasoned approach to
trade appears to be emerging which would remove a potential negative.
On the other
hand, the turmoil over the healthcare bill is a good illustration that the
Donald’s fiscal program has a rocky road ahead of it, however great it may
sound on paper. I continue to believe
that something positive will come from changes in fiscal policy; and they will
likely be enough to alter our long term secular economic growth rate assumption
in our Models. However, I also believe
that they will take longer and have less impact than seems to be Street
consensus at this time.
This week’s
data:
(1)
housing: weekly mortgage applications were down, while
purchase applications were up,
(2)
consumer: month to date retail chain store sales growth
improved from the prior week; March
light vehicle sales were the lowest in nine months; weekly jobless claims fell
more than forecast; the March ADP private payroll report was much stronger than
anticipated but nonfarm payrolls were weaker,
(3)
industry: the Markit March manufacturing and services
PMI’s declined from the prior month; the March ISM manufacturing index was
slightly ahead of expectations while the nonmanufacturing index was well below;
February construction spending was below estimates; February factory orders and
February wholesale inventories were in line,
(4)
macroeconomic: the February trade deficit was below
forecast.
The
Market-Disciplined Investing
Technical
In the face of
some charged headlines, the indices (DJIA 20656, S&P 2355) sold off calmly,
remaining below the upper boundaries of their very short term downtrends.
Volume fell; breadth was mixed. The VIX
(12.9) rose 3 ¾ %, ending above the lower boundary of its very short term
uptrend, above its 100 day moving average for the third day (reverting to
support), below, but near, its 200 day moving average (now resistance) and in a
short term downtrend. Complacency
remains an issue.
The Dow closed
[a] above its 100 day moving average, now support, [b] above its 200 day moving
average, now support, [c] in a short term uptrend {19268-21635}, [c] in an
intermediate term uptrend {11891-24743} and [d] in a long term uptrend
{5751-23390}.
The S&P
finished [a] above its 100 day moving average, now support, [b] above its 200
day moving average, now support, [c] within a short term uptrend {2254-2587},
[d] in an intermediate uptrend {2084-2688} and [e] in a long term uptrend
{905-2591}.
The long
Treasury was down fractionally, remaining above its 100 day moving average (now
support), below its 200 day moving average (now resistance), below but near a
minor resistance level, in a very short term downtrend and in a short term
trading range.
GLD rose,
closing above its 100 day moving average (now support), below but nearing its
200 day moving average (now resistance) and within a short term downtrend.
The dollar was
up strong, ending above its 100 day moving average (now support), above its 200
day moving averages (now resistance; if it remains there through the close next
Wednesday, it will revert to support), right on the upper boundary of its very
short term downtrend and in a short term uptrend.
Bottom line: yesterday,
the Market followed the pattern I opined on in the Morning Call: it seems like
no matter the import of a headline (development), it is not enough to jar either
buyers or sellers loose from their pre-existing investment scenarios. So it would appear that it will take
something extraordinary to break that mindset.
The
TLT, the dollar and gold are on the verge of breaking trends, which if
successful would point to Trumpflation.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (20656)
finished this week about 61.0% above Fair Value (12823) while the S&P (2355)
closed 48.5% overvalued (1585). ‘Fair
Value’ will likely be changing based on a new set of fiscal/regulatory policies
which may lead to an as yet undetermined improvement in the historically low
long term secular growth rate of the economy; but it still reflects the
elements of a botched Fed transition from easy to tight money and a ‘muddle
through’ scenario in Europe, Japan and China.
This week’s US economic
data turned negative; and the accompanying anecdotal evidence didn’t help. As I noted above, the Atlanta Fed has once again
dropped its estimate of first quarter GDP growth to just 0.6%. Of course, we need more data before making
any conclusion about a poor one week performance. That said, as you know, I recently raised our
short term growth forecast based on the thesis that the rise in post-election
sentiment would eventually be reflected in the hard data; so as I said, I
certainly would not alter our outlook based on one week’s stats. But given the difficulties that the
Donald/GOP have had implementing its fiscal program, it wouldn’t be a surprise
that companies/consumers may be retreating from earlier more ambitious spending
programs since that post-election rise in sentiment was premised on an early
enactment of sweeping fiscal changes.
On a long term
basis, I feel like I am on firmer ground modestly raising the secular economic
growth rate in our Models based on Trump’s good work at deregulation. In
addition, the recent release of the proposed changes to NAFTA are not nearly as
onerous as was suggested in the Donald’s campaign rhetoric. Assuming that other
changes in our trading relations are similar, then what I had feared could be a
major economic negative will be eliminated.
Finally, if Trump/GOP
can successfully enact a fiscal program, I will likely raise the secular growth
rate assumption again; although I have no thought on the order of
magnitude. However, I have made it clear
that based on the budget math, I seriously doubt that the final product will be
anywhere near as positive as many on the Street believe.
All that being said, you know that my negative
outlook for stocks has little to do with the progress or lack thereof for the economy/corporate
profits and is directly related to the irresponsibly aggressive global central
bank monetary policy which has led to the gross misallocation and mispricing of
assets.
As you know, my thesis all along has been that since the
economy was little helped by QE/ZIRP, then it could do just fine in the face of
a reversal of those policies. On the
other hand, since the Markets were the primary beneficiaries of Fed largesse,
it would be they who suffered when the Fed began to tighten.
Net, net, my
biggest concern for the Market is the unwinding of the gross mispricing and
misallocation of assets caused by the Fed’s (and the rest of the world’s
central banks) wildly unsuccessful, experimental QE policy. In
addition, while I am encouraged about the changes already made in regulatory
policy as well as a more rational approach to trade, I caution investors not to
get too jiggy about the potential improvements coming in fiscal policy and the
rate of any accompanying acceleration in economic growth and corporate
profitability. If that fails to
materialize it will likely have detrimental effect on Street economic,
corporate profits and Market expectations. Finally, whatever happens, stocks
are at or near historical extremes in valuation and there is no reason to
assume that mean reversion no longer occurs.
The latest from
Doug Kass (medium):
Bottom line: the
assumptions in our Economic Model are beginning to improve as we learn about
the new fiscal/regulatory policies and their magnitude. However, I think the timing and magnitude of
the end results will less than the current Street narrative suggests---which
means Street models will ultimately will have to lower their consensus of the Fair
Value for equities.
Our Valuation
Model are also changing as I raise our long term secular growth rate
assumption. This will, in turn, lift the
‘E’ component of Valuations; but there is a decent probability that this could
be at least partially offset by a lower discount factor brought on by higher
interest rates/inflation and/or the reversal of seven years of asset mispricing
and misallocation. In any case, even
with the improvement in our growth assumption the math in our Valuation Model
still shows that equities are way overpriced.
As a long term investor, with
equity valuations at historical highs, I would use the current price strength
to sell a portion of your winners and all of your losers. If I were a trader, I would consider buying a
Market ETF (VIG, VYM), using a very tight stop.
DJIA S&P
Current 2017 Year End Fair Value*
13200 1630
Fair Value as of 4/30/17 12864
1590
Close this week 20656 2355
Over Valuation vs. 4/30 Close
5% overvalued 13507 1669
10%
overvalued 14150 1749
15%
overvalued 14793 1828
20%
overvalued 15436 1908
25%
overvalued 16080 1987
30%
overvalued 16723 2067
35%
overvalued 17366 2146
40%
overvalued 18009 2226
45%
overvalued 18652 2305
50%
overvalued 19296 2385
55%overvalued 19939 2464
60%overvalued 20582 2544
65%overvalued 21225 2623
70%overvalued 21868 2703
Under Valuation vs. 4/30 Close
5%
undervalued 12220
1510
10%undervalued 11577 1431
15%undervalued 10934 1351
* Just a reminder that the Year
End Fair Value number is based on the long term secular growth of the earning
power of productive capacity of the US
economy not the near term cyclical
influences. The model is now accounting
for somewhat below average secular growth for the next 3 to 5 years.
The Portfolios and Buy Lists are
up to date.
Steve Cook received his education
in investments from Harvard, where he earned an MBA, New York University, where
he did post graduate work in economics and financial analysis and the CFA
Institute, where he earned the Chartered Financial Analysts designation in
1973. His 47 years of investment
experience includes institutional portfolio management at Scudder. Stevens and
Clark and Bear Stearns, managing a risk arbitrage hedge fund and an investment
banking boutique specializing in funding second stage private companies. Through his involvement with Strategic Stock
Investments, Steve hopes that his experience can help other investors build
their wealth while avoiding tough lessons that he learned the hard way.
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